7/29/2003 @ 9:30AM

Venture Funding Sneaks Up

The precipitous two-and-half-year decline in large-scale venture capital investing in the U.S. ended in the second quarter of 2003, according to a new survey, but the level of venture investment is still as low as it has been in six years.

Investments totaled $4.3 billion, up marginally from $4 billion in the first quarter of 2003, according to the PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association MoneyTree Survey. A total of 669 entrepreneurial companies received funding in the second quarter compared to 647 companies in the first quarter of this year.

The number of firms receiving their first formal venture funding rose to 153 from an eight-year low of 138 in the previous quarter, the survey indicates. It also suggests that the rate of decline slowed dramatically over the prior nine months, pointing toward a leveling of overall investing activity.

The amount of venture capital funding was a closely watched indicator during the late 1990s technology boom. But in retrospect, the surge of investment in new, unproven enterprises, followed by their premature entry into public markets, was an indicator of an excess of investment more than anything else. Venture capital investing hit its high point in early 2000, just when the overall market was about to decline, not when it was ready to surge. More than 8,000 companies received formal venture funding that year as the door to the public markets seemed infinitely wide, and the appetite for the next
Cisco Systems
,
JDS Uniphase
or
Amazon.com
–or even the next
Pets.com
–seemed infinite. Currently, the amount of venture spending in the most recent quarter was roughly the same as it was at the beginning of 1998.

“Is this quarter a harbinger of a dramatic turnaround in venture capital investing? It’s not likely,” said
Mark
Heesen
Mark Heesen
, president of the National Venture Capital Association in a statement. “The venture industry invests based on anticipated future market conditions, so before we declare a trend reversal we must first see a sustained opening of the IPO market and consecutive quarterly increases in corporate capital expenditures.”

Heesen is referring to large-scale formal venture investing from the types of firms that occupy Sandhill Road in Silicon Valley. Even at today’s reduced levels, the average investment reported by the MoneyTree survey was $6.4 million. The vast majority of new companies never get this kind of investment and typically gain seed capital in less formal ways, such as from friends, family and business associates. Even in the U.S., where formal venture investing is most prolific, just 28% of the investment in entrepreneurial ventures comes from financiers in the full-time business of venture funding. The remaining 72% is informal, according to a recent study conducted for the Kauffman Foundation.

Formal venture spending gets far more attention, however, than the informal sector. Among the companies that attract this type of capital, software firms led the pack, with 179 companies drawing $864 million (an average of $4.8 million). Software was followed by biotechnology, with $639 million going to 66 companies (average: $9.7 million), and medical devices, with 52 companies drawing $437 million (average: $8.4 million).

The trend is towards later-stage investing, the survey says. Investment in so-called “expansion stage” firms actually increased slightly to $2.3 billion, or 54% of total investments. This was partially offset by an increase in investing in later-stage companies, to $958 million, or 22% of total investments. “It doesn’t necessarily mean that early-stage investing will subside, but due diligence on early-stage and startup deals is a much more rigorous process than it was two years ago, and it will remain so for the foreseeable future,” said
Jesse
Reyes
Jesse Reyes
, vice president at Thomson Venture Economics.